Demand shocks help drive food, commodity prices

A new report from Purdue University researchers and Farm Foundation, NFP shows emerging trends that make this year’s dramatic increase in food and commodity prices different from the increases seen in 2008. But like in 2008, there is no single or simple cause, with numerous domestic and international factors contributing.

Two “demand shocks” – corn used for ethanol and China’s imports of soybeans – play key roles in this year’s market trends, according to the report, titled “What’s driving food prices in 2011?”

Farm Foundation, NFP commissioned Purdue economists to prepare the report, which follows similar analysis they conducted in 2008 and 2009. The authors identified five key factors in shaping today’s price story:

Persistent demand shocks: The report specifically cites demands of the biofuels industry, particularly for corn, and China’s decision to import huge quantities of soybeans due to income growth and stocks-building. The report notes that food, seed and industrial (FSI) use of corn has expanded rapidly in the past five to seven years. Since the 2005-2006 marketing year, 88 percent of the growth in total world corn use has been in the FSI category, where ethanol production is placed. As for soybeans, since 2005-2006, annual Chinese soybean purchases have more than doubled, representing more than 90 percent of the increase in world imports.

Inelasticity of supply and demand: A reduction in the responsiveness of demand and supply to changes in price influences today’s markets. The report notes for example that in the United States, with limited suitable land available for expanded crop production, farmers reallocate acreage from one crop to another based on demand, while globally, 70 percent of expanded acres used to grow high demand crops was new land brought into production. Our current energy policy also creates inelasticity in that Renewable Fuel Standards would support demand for corn for ethanol even if fuel prices dropped.

Weather and effects on grain stocks: Weather is a bigger issue in 2011 than in 2008, the report notes. Corn stocks were drawn down when U.S. yields dropped in 2010. The researchers say tight world stocks for corn and soybeans cannot be overcome in one year of normal yields. High prices will exist for two crop years or longer, before moderating to levels lower than 2011 peaks but still higher than historic norms.

Chinese Policies: China has been a major holder of agricultural commodities but the stocks-to-use ratio of each commodity has varied considerably over the past decade. The policy to accumulate substantial soybeans stocks through imports is one example of the impact on world markets.

Macroeconomics: A weaker U.S. dollar contributed to a commodity boom between 2002 and 2008. Today, changes are not as dramatic, but the dollar exchange rate remains weak and volatile.